How widely accepted is Efficient Market Theory in 2017?

I’m currently reading through “A Random Walk Down Wall Street” by academic Burton Malkiel. While insightful and entertaining, I couldn’t help but notice the author’s adamance that beating the market is a mixture of luck and chance timing.

Malkiel supports his hypothesis by charting returns of successful funds throughout the past three decades versus the average return of common market indices. The star-studded managers with 50%+ returns one year would drop to minute or negative returns the following year(s), balancing out their average returns comparable to a market index.

He also raked technical and fundamental analysts over the coals, claiming they are on the same totem pole as alchemists and weathermen. Throughout the text, Malkiel makes the argument that reading charts and recognizing “patterns” within the market is a technique employed and marketed by brokers to encourage traders to execute more orders, thus producing more commissions. Yes, there is money to be made via trading, but whenever a trader makes money (or loses money), the broker is getting paid.

This book was originally published in 1973, and has since been updated in the early 2000s. What is the status quo on Efficient Market Theory as of 2017? Malkiel quotes Warren Buffett himself stating he [Buffett] would not employ fundamental analysis today, responding that he’d be much better off investing in an index fund and saving his time.

TLDR: What’s the consensus on Efficient Market Theory as it relates to active investing in 2017? Is it even possible to reach a “consensus” as of yet, or will it continue to be controversial until behavioral finance and ‘true’ pattern recognition come to fruition?

Getting a little philosophical here: Is market prediction, say in 500 years, even probable? Will the fact that it exists become just another variable in Efficient Market Theory, allowing for the current stock prices to have already valued this new information?

12 Comments

All of the studies, if you look at the actual math, almost always show a 5% edge to hand-picking stocks and they always waive it away as statistically insignificant. The paper/study that ARWDWS is based on did this. It was the first study that used Fourier analysis to look for frequency correlations (and found none greater than 5%).
I actually read the paper a few months ago.

> Is market prediction, say in 500 years, even probable?

We have state-space mathematics and computers today and it has not yet been applied to a surprising number of applications.
The missing piece is the Internet of Things; once we have real-time feedback to individual items it will become possible to implement such systems.

I think it depends who you ask. Every big player has an agenda which influences everything they say publicly, since they know their comments are being watched, analysed and over-analysed by anyone for any insight into their plays and can therefore be used to help them with their positions.

In my opinion, even as we move into an age of full automation which will drive out a majority of the emotional plays, there will always be that fundamental human driver to any market. Even if the picks are 100% chosen by AI, those algortihms will have learnt their behavior from, and will be affected by human bias.

>He also raked technical and fundamental analysts over the coals, claiming they are on the same totem pole as alchemists and weathermen.

That’s a bit extreme. Fundamental analysis and meteorologists are not at all on the same level as technical analysts/alchemists

>Is market prediction, say in 500 years, even probable?

500 years? What a riot. You can’t even predict 50 years out, and even 5 years is tough (for example take a look at what people were saying in 2002/2003). Try this on for size – humanity may not even be around in 500 years. Predicting the *stock market* at that time is folly.

The efficient market hypothesis, the idea that a security’s price accurately reflects all public information, is total hogwash in my opinion. Markets are not efficient at all. A lot of the movement is just noise. Large players can temporarily take markets out of balance. Watch the DOM for a day to see for yourself.

Now as far as funds go the issue is that the way markets work make it difficult for any fund to maintain an edge for long. An edge that is large enough for funds to take advantage of is going to be detected by the market, and filled by competition. This eliminates that edge.

However, small retail investors can still find an edge. They have advantages that big institutions don’t have. They can still win by picking good stocks through fundamental analysis. They can still win by taking advantage of the market making and auction processes that drive price movement.

Of course, most people won’t be profitable in such venture. But such edges do exist for those willing to do the work.

I think the author is very wrong. Success in trading is not by luck or chance. For a trader to experience a consistent success in the market, he must know about stock analysis and develop a strategy that fits his analysis and trading style.

The efficient market hypothesis has various degrees and the question really is to what degree the market is efficient. Perfectly efficient markets can’t exist (all information reflected -> stockpicking doesn’t matter -> no one bothers to gather any information so how could it all be reflected?). There isn’t a consensus since all tests require a pricing model and we don’t know how to correctly price stocks (or if it’s even possible).

So I think the main thing here is that people are using returns only, while they should be using risk adjusted returns, and even that only works if we have the correct pricing model (which we don’t) and the market as a whole has a strictly mean-variance utility function (which it doesn’t).

TLDR: The market might be efficient to some degree because we have no fucking idea how a stock should be priced

There are various flavors of the EMH but the most extreme – that equity markets always perfectly discount the future at all times – is considered laughably wrong by many professionals who lived through the NASDAQ bubble, 2008, etc. Markets are clearly prone to manias and panics – periods of temporary emotional extremes.